Let us express both debt and fiscal deficit as a fraction of the GDP. Let D/G be d and F/[(1 + g) × G] be f. Then the constant debt-to-GDP ratio condition becomes:
This gives us:
A country starts off with a certain amount of debt (D) – which is expressed as a fraction of its GDP (D/G = d). It wants to reduce its debt-to-GDP ratio (d). How to do this? There are two ways of asking and answering this question:
1. If the country's GDP grows at a certain rate g, then it must keep its fiscal deficit (as a fraction of its GDP) below some level f. Equation 1 gives us this value of f.
2. If the country maintains its fiscal deficit (as a fraction of its GDP) at a certain level f, then its GDP must grow above some rate g. Equation 2 gives us this value of g.
India's debt-to-GDP ratio is 70% – which is the highest among major industrialising countries. How to reduce this? We can use the two equations given above. Accordingly we have:
A. Maximum fiscal deficit (based on the GDP growth rate)
B. Minimum GDP growth rate (based on the fiscal deficit)
Note: The 2003 Fiscal Responsibility and Budget Management (FRBM) Act states that the government must reduce the fiscal deficit to 3% of GDP.
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